Mutualist Blog: Free Market Anti-Capitalism

To dissolve, submerge, and cause to disappear the political or governmental system in the economic system by reducing, simplifying, decentralizing and suppressing, one after another, all the wheels of this great machine, which is called the Government or the State. --Proudhon, General Idea of the Revolution

Economic Calculation in the Corporate Commonwealth: Part III

Rothbard's Application of the Calculation Argument to the Private Sector

Mises argued that socialist governments directing nationalized economies were able to more or less approach economic rationality by setting their internal input prices with reference to foreign prices in countries where markets still prevailed. They would be able to function to some degree, despite the absence of market prices for producer goods, because

these were not isolated socialist systems. They were operating in an environment in which the price system still worked. They could resort to economic calculation on the ground of the prices established abroad. Without the aid of these prices their actions would have been aimless and planless. Only because they were able to refer to these foreign prices were they able to calculate, to keep books, and to prepare their much talked about plans. [Human Action, p. 703]

Murray Rothbard cited an actual example of the use of world market prices in communist planning. Economist Peter Wile reported his discussion with Polish economic planners:

What actually happens is that 'world prices,' i.e. capitalist world prices, are used in all intra-block trade. They are translated into rubles...and entered in bilateral clearing accounts. To the question, 'What would you do if there were no capitalist world?' came only the answer 'We'll cross that bridge when we come to it.' In the case of electricity the bridge is already under their feet: there has been great difficulty in pricing it since there is no world market.' [P. J. D. Wiles,"Changing Economic Thought in Poland,"Oxford Economic Papers 9 (June 1957): 202-3. In Rothbard, "Ludwig von Mises and Economic Calculation Under Socialism," Laurence S. Moss, ed., The Economics of Ludwig von Mises (Kansas City: Sheed and Ward, Inc., 1976), p. 72]

In Man, Economy, and State, Rothbard applied the calculation argument to the private sector firm in a market economy, raising the question of "the role of implicit earnings and calculation in a vertically integrated firm." [Man, Economy, and State, p. 545]

The firm buys labor and land factors at both the fifth and the fourth stages; it also makes the fourth-stage capital goods itself and uses them in another plant to make a lower-stage good....

Does such a firm employ calculation within itself, and if so, how? Yes. The firm assumes that it sells itself the fourth-rank capital good. It separates its net income as a producer of fourth-­rank capital from its role as producer of third-rank capital. It calculates the net income for each separate division of its enter­prise and allocates resources according to the profit or loss made in each division. It is able to make such an internal calculation only because it can refer to an existing explicit market price for the fourth-stage capital good. In other words, a firm can accurately estimate the profit or loss it makes in a stage of its enterprise only by finding out the implicit price of its internal product, and it can do this only if an external market price for that product is established else­where.

On the other hand, suppose that there is no external market, i.e., that the Jones Company is the only producer of the inter­mediate good. In that case, it would have no way of knowing which stage was being conducted profitably and which not. It would therefore have no way of knowing how to allocate factors to the various stages. There would be no way for it to estimate any implicit price or opportunity cost for the capital good at that particular stage. Any estimate would be completely arbitrary and have no meaningful relation to economic conditions.

In short, if there were no market for a product, and all of its exchanges were internal, there would be no way for a firm or for anyone else to determine a price for the good. A firm can estimate an implicit price when an external market exists; but when a market is absent, the good can have no price, whether implicit or explicit. Any figure could be only an arbitrary symbol. Not being able to calculate a price, the firm could not rationally allocate factors and resources from one stage to another.

Since the free market always tends to establish the most efficient and profitable type of production (whether for type of good, method of production, allocation of factors, or size of firm), we must conclude that complete vertical integration for a capital­-good product can never be established on the free market (above the primitive level). For every capital good, there must be a definite market in which firms buy and sell that good. It is obvious that this economic law sets a definite maximum to the relative size of any particular firm on the free market. Because of this law, firms cannot merge or cartelize for complete vertical integra­tion of stages or products. Because of this law, there can never be One Big Cartel over the whole economy or mergers until One Big Firm owns all the productive assets in the economy. The force of this law multiplies as the area of the economy increases and as islands of noncalculable chaos swell to the proportions of masses and continents. As the area of incalculability increases, the degrees of irrationality, misallocation, loss, impoverishment, etc., become greater. Under one owner or one cartel for the whole productive system, there would be no possible areas of calculation at all, and therefore complete economic chaos would prevail.

Economic calculation becomes ever more important as the market economy develops and progresses, as the stages and the complexities of type and variety of capital goods increase. Ever more important for the maintenance of an advanced economy, then, is the preservation of markets for all the capital and other producers’ goods.

Our analysis serves to expand the famous discussion of the possibility of economic calculation under socialism, launched by Professor Ludwig von Mises over 40 years ago. Mises, who has had the last as well as the first word in this debate, has dem­onstrated irrefutably that a socialist economic system cannot cal­culate, since it lacks a market, and hence lacks prices for pro­ducers’ and especially for capital goods. Now we see that, para­doxically, the reason why a socialist economy cannot calculate is not specifically because it is socialist! Socialism is that system in which the State forcibly seizes control of all the means of production in the economy. The reason for the impossibility of calculation under socialism is that one agent owns or directs the use of all the resources in the economy. It should be clear that it does not make any difference whether that one agent is the State or one private individual or private cartel. Whichever oc­curs, there is no possibility of calculation anywhere in the pro­duction structure, since production processes would be only internal and without markets. There could be no calculation, and therefore complete economic irrationality and chaos would pre­vail, whether the single owner is the State or private persons.

The difference between the State and the private case is that our economic law debars people from ever establishing such a system in a free-market society. Far lesser evils prevent entrepre­neurs from establishing even islands of incalculability, let alone infinitely compounding such errors by eliminating calculability altogether. [Man, Economy, and State, pp. 545-49]

Rothbard further elaborated on this argument in "Ludwig von Mises and Economic Calculation Under Socialism":

There is one vital but neglected area where the Mises analysis of economic calculation needs to be expanded. For in a profound sense, the theory is not about socialism at all! Instead, it applies to any situation where one group has acquired control of the means of production over a large area—or, in a strict sense, throughout the world. On this particular aspect of socialism, it doesn't matter whether this unitary control has come about through the coercive expropriation brought about by socialism or by voluntary processes on the free market. For what the Mises theory focuses on is not simply the numerous inefficiencies of the political as compared to the profit-making market process, but the fact that a market for capital goods has disappeared. This means that, just as Socialist central planning could not calculate economically, no One Big Firm could own or control the entire economy. The Mises analysis applies to ay situation where a market for capital goods has disappeared in a complex industrial economy, whether because of socialism or because of a giant merger into One Big Firm or One Big Cartel.

If this extension is correct, then the Mises analysis also supplies us the answer to the age-old criticism leveled at the unhampered, unregulated free-market economy: what if all firms banded together into one big firm that would exercise a monopoly over the economy equivalent to socialism? The answer would be that such a firm could not calculate because of the absence of a market, and therefore that it would suffer grave losses and dislocations. Hence, while a Socialist Planning Board need not worry about losses that would be made up by the taxpayer, One Big Firm would soon find itself suffering severe losses and would therefore disintegrate under this pressure. We might extend this analysis even further. For it seems to follow that, as we approach One Big Firm on the market, as mergers begin to eliminate capital goods markets in industry after industry, these calculation problems will begin to appear, albeit not as catastrophically as under full monopoly. In the same way the Soviet Union suffers calculation problems, albeit not so severe as would be the case were the entire world to be absorbed into the Soviet Union with the disappearance of the world market. If, then, calculation problems begin to arise as markets disappear, this places a free-market limit, not simply on One Big Firm, but even on partial monopolies that eradicate markets. Hence, the free market contains within itself a built-in mechanism limiting the relative size of firms in order to preserve markets throughout the economy. This point also serves to extend the notable analysis of Professor Coase on the market determinants of the size of the firm, or of the relative extent of corporate planning within the firm as against the use of exchange and the price mechanism. Coase pointed out that there are diminishing benefits and increasing costs to each of these two alternatives, resulting, as he put it, in an"'optimum' amount of planning"in the free market system." Our thesis adds that the costs of internal corporate planning become prohibitive as soon as markets for capital goods begin to disappear, so that the free-market optimum will always stop well short not only of One Big Firm throughout the world market but also of any disappearance of specific markets and hence of economic calculation in that product or resource. ["Ludwig von Mises and Economic Calculation under Socialism," pp. 75-76]

The main shortcoming of Rothbard's analysis is that, as Peter Klein characterized it,

Rothbard is making a claim only about the upper bound of the firm, not the incremental cost of expanding the firm's activities (as long as external market references are available). ["Economic Calculation and the Limits of Organization," The Review of Austrian Economics Vol. 9 No. 2 (1996).]

But the larger and more vertically integrated the corporation, even when outside markets continue to exist for all its inputs, the further removed are its internal conditions from the immediate conditions under which prices are formed moment to moment in the outside market. The external market prices are to some extent arbitrary, reflecting the situation of market actors outside the firm rather than the situation within the firm. Pricing based on the available supply and the valuation of purchasers under the spot conditions of the market may lead to irrational allocations given different conditions of supply and valuation within the firm. If nothing else, the fact that the firm is "exchanging" factors internally, rather than bidding in the outside market, distorts the price in the outside market so that it is different from what it would be if the firm were a participant in it. The outside market's prices are atypical or misleading precisely to the extent that they do not incorporate the valuations of the firm in question. Rothbard himself admitted as much, in a footnote to Man, Economy and State:

The implicit price, or opportunity cost of selling to oneself, might be less than the existing market price, since the entry of the Jones Company on the market might have lowered the price of the good, say to 102 ounces. [900-01, n56]

On this, Peter Klein comments:

Unlike Hirshleifer (1956), then, Rothbard does not require the external market to be perfectly competitive for a market-based transfer price to be economically meaningful. For Rothbard, "thin" markets are adequate: all that is necessary to have a genuine "external market" is the existence of at least one other producer (seller) of the intermediate good. ["Economic Calculation and the Limits of Organization," p. 14 n. 13; reference is to Jack Hirshleifer, "On the Economics of Transfer Pricing," Journal of Business 29 (1956): 172-89]

But this is unsatisfactory. The outside market price is as approximate and distorted, from the standpoint of the firm's internal planners, as market prices in the West were to Soviet state planners. Or at least, the unsatisfactoriness and approximateness are similar in kind, if not degree. If all that matters is that some external market continue to exist, no matter how unrepresentative of conditions within the firm, then a state-planned economy ought to work just fine on implicit pricing based on foreign markets, so long as some market continued to exist anywhere in the world.

On the other hand, Rothbard's size threshold in its practical effect might be quite low if, as he seemed to suggest, the requirement for "factor markets" applies to intermediate components or unfinished goods as well as basic raw materials. If the component parts of a complex consumer good are to some extent unique and differentiated from the components of competing versions of that good, in ways that prevent generic pricing of the components, the firm must set an internal transfer price for the component that is estimated on some cost-plus basis. In this case, Rothbard seems to argue, the more indirectly the transfer price is derived from the actual market prices of other producer goods, the further removed from reality are the firm's attempts at calculation. If this is taken as Rothbard's explicit doctrine, then most oligopoly manufacturing corporations probably exceed Rothbard's threshold; the majority of firms would fall within his threshold only where the predominant model of organization was to organize each stage of production as a separate firm and coordinate them by contract.

When no external market exists for intermediate products or components, the usual practice is to estimate the transfer price on a cost-plus basis, or perhaps to allow the buying and selling divisions to bargain in an internal "market." Rothbard (p. 547) dismissed such a transfer price as "only an arbitrary symbol." Peter Klein adds:

At the very least, any artificial or substitute transfer prices will contain less information than actual market prices... ["Economic Calculation and the Limits of Organization," p. 14]

The problem is complicated by the general distortion of prices under state capitalism. If prices for production inputs are necessary for economic calculation, then subsidies and other externalities caused by state intervention will distort the basic data on which coherent entrepreneurial decisionmaking will be based; the result is a tendency toward calculational chaos. [I'm indebted to Oisin O'Connell for making this connection, in his paper "The Green Star Idea" (unpublished course paper, 2007)]

Rothbard's assertion that "[f]ar lesser evils prevent entrepreneurs from establishing even islands of incalculability," under corporate capitalism, is quite doubtful. He neglects the extent to which the large corporation, as an island of incalculability, is insulated from the market penalties for calculational chaos.

The existing state capitalist system has promoted economic centralization and large scale to the extent that it is impossible for any decisionmaker to aggregate the distributed knowledge necessary to take both entrepreneurial and technical questions into account in making a rational decision. But the large corporate firm operates in an enviroment of restraints on competition, shared cultures of inefficiency with other firms in the same industry, and push distribution models, so that it is insulated to a considerable degree from the consequences of irrational decisions.

In fact, the parallels between the kinds of uneven development and misallocation that exist under state socialism, and the equivalent phenomena under state capitalism, are striking. The corporate economy, as a whole, operates in nearly the same atmosphere of calculational chaos as the Soviet planned economy. Like the Soviet planned economy, it is able to stagger on because it does at least translate production inputs into real use-value. But like the Soviet planned economy, its managers have little idea whether the use-value produced came at the expense of some other, greater use-value that might otherwise have resulted from the same inputs. Like the Soviet economy, it has little idea of the comparative efficiency or inefficiency with productive inputs have been used. Like the Soviet planned economy, although to a lesser extent, it is insulated from competition by those who might more accurately assess the needs of consumers or organize resources more efficiently in meeting those needs.

The problem with a state economy, as Mises pictured it, was not that it would be incapable of technical sophistication. A state socialist economy might produce use-value. The problem is that the planners would have absolutely no idea whether the use-value created was worth the cost: did it absorb inputs that might have been used for some greater use value? "All economic change... would involve operations the value of which could neither be predicted beforehand nor ascertained after they had taken place. Everything would be a leap in the dark." [Socialism: An Economic and Sociological Analysis. Translated by J. Kahane. New edtion, enlarged with an Epilogue (New Haven: Yale University Press, 1951).

Richard Ericson remarked on the ability of communist systems to achieve great feats of engineering without regard to cost:

When the system pursues a few priority objectives, regardless of sacrifices or losses in lower priority aras, those ultimately responsible cannot know whether the success was worth achieving." ["The Classical Soviet-Type Economy: Nature of the System and Implications for Reform." Journal of Economic Perspectives 5:4 (1991), p. 21]

Consider also Hayek's prediction of the uneven development, irrationality, and misallocation of resources within a planned economy:

There is no reason to expect that production would stop, or that the authorities would find difficulty in using all the available resources somehow, or even that output would be permanently lower than it had been before planning started.... [We should expect] the excessive development of some lines of production at the expense of others and the use of methods which are inappropriate under the circumstances. We should expect to find overdevelopment of some industries at a cost which was not justified by the importance of their increased output and see unchecked the ambition of the engineer to apply the latest development elsewhere, without considering whether they were economically suited in the situation. In many cases the use of the latest methods of production, which could not have been applied without central planning, would then be a symptom of a misuse of resources rather than a proof of success.

As an example he cited "the excellence, from a technological point of view, of some parts of the Russian industrial equipment, which often strikes the casual observer and which is commonly regarded as evidence of success...." [F. A. Hayek. "Socialist Calculation II: The State of the Debate (1935)," in Hayek, Individualism and Economic Order (Chicago: University of Chicago Press, 1948), pp. 149-50]

To anyone observing the uneven development of the corporate economy under state capitalism, this should inspire a sense of deja vu. Entire categories of goods and production methods have been developed at enormous expense, either within military industry or by state-subsidized R&D in the civilian economy, without regard to cost. [Two of David Noble's works, Forces of Production: A Social History of Industrial Automation (New York: Alfred A. Knopf, 1984), and America by Design: Science, Technology, and the Rise of Corporate Capitalism (New York: Alfred A. Knopf, 1977) are a good starting point on this subject. Miniaturized circuitry, digital control systems for machine tools, cybernetics, and quality control systems--just to name a few examples--were all direct spillovers from the military economy.] Subsidies to capital accumulation, R&D, and technical education radically distort the forms taken by production. Blockbuster factories and economic centralization become artificially profitable, thanks to the Interstate Highway System and other means of externalizing distribution costs.

These quotes on communist central planning also describe quite well the environment of pervasive irrationality within the large corporation: management featherbedding and self-dealing; "cost-cutting" measures that decimate productive resources while leaving management's petty empires intact; and the tendency to extend bureaucratic domain while cutting maintenance and support for existing obligations. Management's allocation of resources no doubt creates use value of a sort--but with no reliable way to assess opportunity cost or determine whether the benefit was worth it.

Conclusion

In this article we have examined the inefficiencies of the large corporation, resulting directly from the internal diseconomies of scale: the separation of economic from technical knowledge; the informational problems of aggregating distributed knowledge in a hierarchy; the agency problems of divorcing the benefits of increased productivity from the knowledge of how to improve the process; and the calculational chaos created by removing internal transfer pricing from its proper basis in the market.

The solution is to avoid hierarchy as much as possible, and to internalize the costs and benefits of organizing production in the same decisionmakers.

Insofar as the production process involves a series of discrete, severable steps, the best way of circumventing informational and incentive problems may be to relate the separate steps to one another by contract--especially if each step, organized under a separate firm, takes the internal form of a producer cooperative.

Each step, although a black box to those outside, from an inside perspective is ideally suited to aggregating all relevant information for consideration by a single group of decision-makers. In a self-managed enterprise, the same elected management that considers the relative prices of different productive inputs, and the price of the finished product, is also experienced in the actual production process in which the inputs are used. They are most qualified, of all people, to decide not only the relative priority by which productive inputs ought to be economized, but the most effective technical methods of organizing production in order to economize those inputs.

From an outside perspective, on the other hand, other contracting firms are able to make a virtue of necessity in treating a particular stage of production--organized as a separate firm--as a black box. The outside contractor and the internal hierarchy are equally ignorant of goings-on inside the black box. The difference is that an outside contractor, unlike a hierarchy, has no need to know what's happening in the internal production process, and no power to interfere with what he doesn't understand. So long as the inputs (likely in money terms) are specified by contract, and the outputs are verifiable and enforceable, what goes on inside the box isn't the outside contractor's problem.

The mainstream of the transaction cost school, the progeny of Coase and Williamson, greatly underestimates the internal agency costs of organizing transactions within a corporate hierarchy. The ideal contract, after all, is "sharp ins by clear agreement, sharp outs by clear performance." It is far simpler and less costly to simply monitor the contractually specified "ins" and "outs" going to and from a contracting firm, than to monitor the internal use of inputs within the production process: the "in" usually consisting simply of an amount of money established by contract, perhaps along with some intermediate goods for processing, and the "out" a finished product of specified quality and quantity. So long as the ins and outs (the money price and the quality and quantity of finished goods) can be effectively monitored, the contracting party has no need to worry about the internal efficiency of the production process. It has effectively outsourced the responsibility for decisions on how best to organize production to those engaged in production.

The contracting firm, if cooperatively owned by self-managed workers, is uniquely qualified to organize production most efficiently given the specified ins and outs. Just as important, unlike a production unit within a corporate hierarchy, the production workers within the contracting producers' co-op fully internalize all the costs and benefits of their production decisions. Unlike the case within a corporate hierarchy, there is no conflict of interests resulting from the making of decisions by managers who stand to reap the benefits of increased productivity while workers suffer only the costs. For a self-managed production unit, any decision concerning production methods will be a tradeoff of costs and benefits, all of which are fully internalized by the decisionmakers.

Thursday, March 22, 2007

Economic Calculation in the Corporate Commonwealth (Part I)

[Note--My last post was an excerpt from Part II of a three-part article I've been working on lately. Since it resulted in a gracious offer of print publication for an article based on that post, I will limit the online posting of Part II to the excerpt as it originally appeared. I'm following it up, however, with Parts I and III.

Since this week's theme is science and technology, I'm submitting this post to Carnival of Anarchy]

Economic Calculation in the Corporate Commonwealth

Introduction. The general lines of Mises' rational calculation argument are well-known. A market in factors of production is necessary for pricing production inputs, so that a planner may allocate them rationally. [Human Action pp. 698-701] The problem has nothing to do either with the volume of data, or with agency problems. The question, rather, is how is the data generated in the first place? [Roderick Long, from a post to the LeftLibertarian yahoogroup] And "[h]ow does the principal know what to tell the agent to do?" [Peter Klein, “Economic Calculation and the Limits of Organization,” The Review of Austrian Economics Vol. 9 No. 2 (1996)] As Rothbard put it, "there can be no implicit estimates without an explicit market!" [Man, Economy, and State, p. 543]

Part I: The Divorce of Entrepreneurial from Technical Knowledge

But the question of whether market price is the only feasible method of making rational decisions about factor inputs (and this was the central question at issue) is far less important, from my standpoint, than what Mises had to say on the relation between technological and entrepreneurial judgments. "Technology," Mises wrote,

shows what could be achieved if one wanted to achieve it, and how it could be achieved provided people were prepared to employ the means indicated....

However, the mere information conveyed by technology would suffice for the performance of calculation only if all means of production--both material and human--could be perfectly substituted for one another according to definite ratios, or if they all were absolutely specific. In the former case all means of production would be fit, although according to different ratios, for the attainment of all ends whatever.... In the latter case each means could be employed for the attainment of one end only.... Neither of these two conditions is present in the universe in which man acts.... The facts that there are different classes of means, that most of the means are better suited for the realization of some ends, less suited for the attainment of some other ends and absolutely useless for the production of a third group of ends, and that therefore the various means allow for various uses, set man the task of allocating them to those employments in which they can render the best service. Here computation in kind as applied by technology is of no avail. Technology operates with countable and measurable quantities of external things and effects; it knows causal relations between them, but it is foreign to their relevance to human wants and desires.... [Technology] ignores the economic problem: to employ the available means in such a way that no want more urgently felt should remain unsatisfied because the means suitable for its attainment were employed--wasted--for the attainment of a want less urgently felt.... Technology tells how a given end could be attained by the employment of various means which can be used together in various combinations.... But it is at a loss to tell man which procedures he should choose out of the infinite variety of imaginable and possible modes of production. What acting man wants to know is how he must employ the available means for the best possible--the most economic--removal of felt uneasiness.... The art of engineering can establish how a bridge must be built in order to span a river at a given point and to carry definite loads. But it cannot answer the question whether or not the construction of such a bridge would withdraw material factors of production and labor from an employment in which they could satisfy needs more urgently felt....

Technology and the considerations derived from it would be of little use for acting man if it were impossible to introduce into their schemes the money prices of goods and services. The projects and designs of engineers would be purely academic if they could not compare input and output on a common basis. [Human Action, pp. 206-08. Emphasis added]

Technology describes the different technical possibilities for organizing production. At the same time, knowledge of the relative values of inputs is necessary to judge which technical process is most appropriate. Knowledge of technical possibilities, without knowledge of the relative value of production inputs to each other and to the finished product, is empty. But although Mises neglected to mention it, the opposite is true as well. Knowledge of the money prices of production inputs, and of finished goods, would be purely academic without the knowledge of how to organize production so as to economize on the most valuable inputs and to organize means properly in relation to ends.

Knowledge of the value of inputs without knowledge of their concrete use in the production process results in calculational chaos, to the very same extent as the reverse state of affairs. What Mises regarded as the "entrepreneurial" realm (whether the entrepreneurs be finance capitalists or corporate management), to the extent that it is isolated from knowledge of the production process, is an island of calculational chaos.

Fully rational decisions are possible only if the knowledge of the relative value of inputs is combined with knowledge of how those inputs are to be used internally. The separation of ownership of capital from the knowledge of the production process leads to decisions divorced from reality. The same is true of the separation of management from direct involvement in the production process, and the accountability of management to absentee owners rather than to workers. These functions are separated under large-scale corporate capitalism. The manager who knows much about the cost of production inputs, but lacks technical knowledge of the ends to which they are best suited, is ignorant and unqualified to judge "those employments in which they can render the best service." If he attempts "cost cutting measures," he is likely to use poor judgment as to which inputs can most afford to be cut, and reduce expenditures on the most important productive inputs first.

This is true regardless of whether Mises was right, or Lange and Schumpeter were right. The feasibility of non-price calculation of the relative value of production inputs is irrelevant. Under any system, whatever the method of calculating the relative value of producer goods, price or non-price, knowledge of the value of producer goods must be integrated with knowledge of the technical possibilities for using them. In any system, price or non-price, in which organizational size goes beyond the possibility of such integration, decisions will become irrational. So the management of a large corporation is operating in the same island of calculational chaos as the management of an old Soviet industrial ministry. The problem attends any system in which those who control the allocation of resources lack adequate knowledge of the effect their decisions will have on the production process.

It also makes little difference whether the entrepreneurial function of large-scale allocation of investment resources is carried out by outside investors and financiers, or internally by senior management. In their ignorance of the production side of things, the cluelessness of senior corporate management and the cluelessness of outside money shufflers are both of a kind. The investment bankers and rentiers simply shuffle money from one venture to another based on the expected return, while seeing the internal production process as a black box. But senior management, MBA types who focus on finance and marketing almost to the exclusion of production, likewise see the actual production operations of the firm as a black box.

Mises' contrast between the entrepreneur and the corporate manager, and his treatment of corporate bureaucracy, are fundamentally flawed. Mises overplayed the distinction between the entrepreneur and the mere corporate manager. He neglected the amount of investment generated internally through retention of profits, and likewise neglected the role of the senior management of an M-form corporation in allocating finance between divisions. He also ignored the extent of corporate management's discretion in how to spend available capital--i.e., to choose between alternative forms of production technology. At times, the entrepreneurial role of finance capital in allocating resources among firms becomes great indeed--as it has in the current era of the hostile takeover, with the elevation of global finance to its position of preeminence. At other times, the relative power of corporate management to make investment decisions is much greater--as it was in the early postwar form of corporate capitalism that Galbraith described. But at all times, including now, the entrepreneurial leeway of corporate management is considerable.

Mises also erred in the sharp contrast he made between the entrepreneurial function and the "mere" organization of production.

The entrepreneur determines alone, without any managerial interference, in what lines of business to employ capital and how much capital to employ. He determines the expansion and contraction of the size of the total business and its main sections. He determines the enterprise's financial structure. These are the essential decisions which are instrumental in the conduct of business. [Human Action, p. 307]

First of all, the general environment Mises assumes is a historically determined one, in no way necessarily connected to the essential features of the market economy as such. Mises assumes a society in which most investment capital is concentrated in the hands of a relatively small plutocratic class, the dominant form of enterprise is the large corporation, and investment decisions involve mainly the movement of large blocks of capital between the enormous enterprises. As an indication of his culturally bound conception of entrepreneurship, consider his equation of that function to the existence of "the stock and commodity exchanges, the trading in futures, and the bankers and moneylenders...." [Human Action pp. 708-09] In fact, he actually considered the existence of a stock market--which assumes the corporation as the dominant form of enterprise and corporate equity as the dominant form of property--the defining feature of a market society. As Murray Rothbard recounted:

One time, during Mises' seminar at New York University, I asked him whether, considering the broad spectrum of economies from a purely free market economy to pure totalitarianism, he could single out one criterion according to which he could say that an economy was essentially "socialist" or whether it was a market economy. Somewhat to my surprise, he replied readily: "Yes, the key is whether the economy has a stock market." That is, if the economy has a full-scale market in titles to land and capital goods. In short: Is the allocation of capital basically determined by government or by private owners? ["The End of Socialism and the Calculation Debate Revisited," The Review of Austrian Economics Vol. 5, No. 2 (1991), p. 59]

Actually, the significance of a stock market is that the economy has a full-scale market in equity in firms, not in "titles to land and capital goods." Rothbard was almost as prone as Mises to confuse the historical accidents of corporate capitalism with the essence of markets, property and entrepreneurship.

Consider: if what the radical economists call primitive accumulation--the expropriation of the laboring classes in early modern times--had not taken place, a market society of small-scale property and worker-ownership might have evolved. Had the state not subsidized the corporate revolution and economic centralization, the economy might have remained dominated by small factories or artisan shops, with manufacturing consisting of small-scale machine production for local markets. In such an economy, the "entrepreneurial" function would have involved mainly the decision by workers themselves as to the reinvestment of their savings from labor income, supplemented by small loans financed by the cooperative pooling of such savings. Mises' basic description of the entrepreneur's function involves not the essential functions of employing resources as such, but the particular historical form that those functions have taken under state capitalism. Incidentally, in arguing that "Syndicalism" would not allow a market in factors of production, Mises made the same mistake of confusing a market in producer goods with a market in equity in firms. Rothbard, in assuming that an economy of producer cooperatives would rule out markets in credit or capital goods, likewise erred. [Man, Economy, and State, p. 544]

Entrepreneurship, in fact, is inseparable from decisions involving the direct organization of production. The "minor" decisions of which Mises was so dismissive, and the "great" decisions he regarded as truly entrepreneurial, are the same in kind. Shuffling great blocks of money around between enterprises, or between the divisions of an M-form corporation, are not different in kind from decisions of what kind of machinery to buy, how to link it together, and how to organize the human tasks of production around the machinery.

Start close to the small end of the scale, from the perspective of a small shop using small-scale production machinery: it is perhaps owned by a self-employed producer, or, if somewhat larger, a small factory cooperatively owned by its production workers. There is a wide range of possible ratios of input to output possible, depending on minute changes in the technical process of production. According to Barry Stein, a series of seemingly minor and incremental changes in the production process in an older factory with older machinery, "tweaking" things a bit here or there, often has a greater cumulative effect on productivity than building an entirely new factory with the latest generation of production machinery. [Size, Efficiency, and Community Technology] In these cases, such technical decisions have a larger effect on the total allocation of resources among ends than the decisions of investment bankers.

And the producers' decision of which technical means to choose and how to organize them is very much an entrepreneurial calculation that must take into account the relative costs of all the production inputs. Any meaningful decision to finance some new purchase of machinery or otherwise change the organization of production--whether from savings from the shop's income or through a small bank loan--will be inseparable from such an understanding of the production process. The self-employed production workers must also possess a knowledge of the local market for their product, how demand and price fluctuate with changing business conditions, and so forth--all quite entrepreneurial.

Multiply the scale of this shop by a thousand or more, and the only difference is that the people making the finance and marketing decisions are almost entirely isolated from the nuts and bolts knowledge of production, outside of which context their decisions are almost meaningless.

Mises at times came close to admitting as much, mentioning in passing that "[t]he function of the entrepreneur cannot be separated from the direction of the employment of factors of production for the accomplishment of definite tasks." [Human Action, p. 306] Or as he wrote at greater length elsewhere:

The entrepreneurs are not omnipresent. They cannot themselves attend to the manifold tasks which are incumbent upon them. Adjustment of production to the best possible supplying of the consumers with the goods they are asking for most urgently does not merely consist in determining the general plan for the utilization of resources. There is, of course, no doubt that this is the main function of the promoter and speculator. But besides the great adjustments, many small adjustments are necessary too. Each of them may seem trifling and of little bearing upon the total result. But the cumulative effect of shortcomings in many of these minor matters can be such as to frustrate entirely the success of a correct solution of the great problems. At any rate, it is certain that every failure to handle the smaller problems results in a squandering of scarce factors of production and consequently in impairing the best possible satisfaction of the consumers. [Human Action, pp. 303-04]

The problem seems to lie in his obstinate relegation of the "technician," as such, to a "purely technological point of view," and his dichotomy between the "entrepreneur, as such" and the technician, when the actual function of entrepreneurship is so closely intertwined with technical decisions. Mises' teachable moment having seemingly come and gone, he continued in the same passage:

It is important to conceive in what respects the problem we have in mind differs from the technological tasks of the technicians. The execution of every project upon which the entrepreneur has embarked in making his decision with regard to the general plan of action requires a multiplicity of minute decisions. Each of these decisions must be effected in such a way as to prefer that solution of the problem which--without interfering with the designs of the general plan for the whole project--is the most economical one. It must avoid superfluous costs in the same way as does the general plan. The technician from his purely technological point of view either may not see any difference in the alternatives offered by various methods for the solution of such a detail or may give preference to one of these methods on account of its greater output in physical quantities. But the entrepreneur is actuated by the profit motive. This enjoins upon him the urge to prefer the most economical solution, i.e., that solution which avoids employing factors of production whose employment would impair the satisfaction of the more intensely felt wants of the consumers. He will prefer among the various methods with regard to which the technicians are neutral, the one the application of which requires the smallest cost. He may reject the technicians' suggestion to choose a more costly method securing a greater physical output if his action shows that the increase in output would not outweigh the increase in cost required. Not only in the great decisions and plans but no less in the daily decisions of small problems as they turn up in the current conduct of affairs, the entrepreneur must perform his task of adjusting production to the demand of the consumers as reflected in the prices of the market. [Human Action p. 304]

The actual person making such technical decisions may have a far better knowledge of the relative money costs of alternative inputs, and of the money cost ratios of inputs and outputs under alternative methods of organizing production, than the "entrepreneur" has of the way that such technical decisions affect his money calculations of cost and benefit. Either way, it's a mistake to separate (even with the magical words "as such") the purely entrepreneurial from the purely technical function. The functions may be separated as a matter of definition. But as Rothbard said, "In the real world, each function is not necessarily performed by a different person." [Man, Economy, and State p. 542] The entrepreneurial and the technical are not so much two different bodies of knowledge, as two different ways of thinking about knowledge. It is possible to consider technical data with entrepreneurial considerations of factor and product prices in mind, as well as the reverse.

In addition, I've seen it argued quite convincingly that the distinction between purely "technical," as opposed to "economic" standards of efficiency, is a strawman; and that the cost of inputs is a basic efficiency consideration for engineers in developing a product or process. Max Chiz, in a comment to a Mises Economics Blog post by Peter Klein, wrote:

First off, I know what I'm talking about on this: I have an undergraduate degree in Electrical Engineering. I've worked in engineering R&D -- building computers. I've built and administrated networks....

It is a general misconception, shared by Dr. Klein, that "technological value is not the same as economic value". The entire job of an engineer, and what you spend years in college learning how to do, is to combine the data of the market (in the form of prices for materials, components, land, buildings, labor, assembly equipment, etc) with knowledge of science to better meet the needs of the customer. Engineers try to find the optimal tradeoff between quality, cost, and time to market. It is true that engineers often describe products in terms of "elegance", "beauty", etc., but these terms would have no meaning if it weren't for the market. A device is "elegant" precisely because of the ingenuity that went into satisfying customers -- it uses less parts (and hence costs less), it fits in less space (and hence has higher quality in the eyes of the customer), it will let you get your product out the door in half the time (and meet consumer desires sooner). I am especially embarrassed that an Austrian blog can't get this simple point -- as it is a critical part of the calculation problem. After all, if I don't have prices for all of those factors, the combination of things I can build is effectively infinite. [Peter Klein, "Government Did Invent the Internet, But the Market Made It Glorious," Mises Economic Blog, June 12, 2006]

In response to a private email, in which I asked Chiz to clarify his position on entrepreneurship in relation to that of Mises, he added:

Engineers do two things:1. They make technology using science.2. They design goods using technology.

#2 requires prices in order to correctly make the trade-offs between time-to-market, quality, and cost.

I don't consider this to be the entrepreneurial function because the uses of the inputs are almost always not marginal (and hence their price will be determined in broader factor markets.)

Both the technician and the entrepreneur possess what Hayek called idiosyncratic knowledge, and neither one can exercise his own art effectively without incorporating the other's art into his own immediate considerations. Knowledge cannot be entirely delegated, because it's impossible to judge someone else's use of his own art without possessing some general knowledge of that art for oneself. Neither specialty's considerations are conducive to being distilled into an executive summary, to be considered by the other specialty as an afterthought after it has already set priorities in terms of its own considerations. The technical possibilities of production have a direct bearing on questions of factor productivity compared to cost, and must be borned in mind continuously as entrepreneurial questions are being considered. The costs of inputs and of the finished product, likewise, have a direct bearing on which technical solution is the most efficient, and must be continuously borne in mind by one considering technical matters. If, as some neurologists suspect, the brain functions as a Bayesian calculating device ("taking various bits of probability information, weighing their relative worth, and coming to a good conclusion quickly," to quote Professor Alex Pouget), this is especially true.

if we want to do something, such as jump over a stream, we need to extract data that is not inherently part of that information. We need to process all the variables we see, including how wide the stream appears, what the consequences of falling in might be, and how far we know we can jump. Each neuron responds to a particular variable and the brain will decide on a conclusion about the whole set of variables using Bayesian inference.

If so, the body of knowledge must be in the original mix. Ideally, it is best if the two ways of thinking are combined in the same group of persons, as much as possible, or at least if the two kinds of thinkers are in close and continuing contact with one another and have an excellent layman's knowledge of their respective fields.

Under state capitalism, however, corporate size is promoted to the point that technical and entrepreneurial judgments are "stovepiped," with specialists making decisions with regard largely to their own field in isolation, and then trying to splice in the considerations of other fields as an afterthought.

When the organization reaches a sufficiently large size, the moneyed "entrepreneur" lacks any direct knowledge of the "various methods" or "minor matters," and hence is likely to be operating in an atmosphere of calculational chaos.

In short, coherent decisions cannot be made unless the relevant "technical" and "entrepreneurial" knowledge are aggregated by the same decisionmakers. And state capitalism has caused to a predominate organizations of such size and complexity that the relevant information cannot be encompassed by any such unified decisionmaker, and there are insurmountable agency problems involved in getting the necessary knowledge of the production process to the people making the grand "entrepreneurial" decisions. If anything, the "technician" and the production worker are probably more qualified to add the entrereneur's legitimate knowledge to their own and take over the functions of ownership and management efficiently for themselves, than the entrepreneur and manager are to obtain adequate knowledge of the production process.

The great investors are almost entirely clueless as to what their supposed "employees," the corporation managers are doing. The CEOs are almost entirely clueless as to what the branch and facility managers are doing. And the management of each facility are almost entirely clueless as to what is going on within the black box of the actual production process. In the light of this reality, Mises' "entrepreneur"--so carefully and closely involved in the minutiae of choosing between technical possibilities of production, a brooding omnipresence guiding the efforts of every employee--is largely a construction of fantasy. It's quite ironic, in fact, considering that Mises starts out the block quote above with the announcement that the entrepreneur is not omnipresent.

The vitality of the American economy results from thousands and thousands of ongoing experiments. Entrepreneurs take an idea and test it in the marketplace. Some ideas are about new products or methods for production, sales or marketing. Still other innovations are in the organization of a firm, its management system and even in the ways of measuring, monitoring and compensating its employees. Markets reward successful entrepreneurs and innovations. Just as importantly, however, markets will punish bad ideas and inefficient behavior. Justice for corporate malfeasance is swift and brutal, as was seen in plummeting stock prices for Enron or Tyco once scandal emerged

Clearly the top-performing CEOs in corporate America earn every penny of their compensation and then some. They create wealth, and by doing so create shareholder value, increased consumer welfare and higher standards of living.

Publicly held companies are designed to maximize profit to their shareholders. Inevitably, some firms will employ poor managers and occasionally a really bad actor. Unless the firm has a strong system for monitoring the quality of executive decision-making, the market will pass judgment quickly in the form of lower or negative returns on investment.

The problem with a one-size-fits-all approach to executive pay is that it punishes the vast majority of the market — where wealth-generating firms and shareholders reside — in order to get at a handful of bad actors who would otherwise be dealt with through market forces.

There is a healthy dose of arrogance in the idea that another law could beat an entrepreneurial marketplace for determining how to evaluate compensation. Poor executive performance shows up quickly on the bottom line.

I won't even bother telling you what I think of Armey, either as a former economics professor or as a professed friend of "free markets." Suffice it to say that, with such defenders of "free markets," it' s no wonder so much of the Left hates markets on principle and sees free market libertarianism as a disingenuous apologetic for corporate interests. If "free markets" really meant what Armey and his paymasters mean by them, I'd hate them too.

But since this ties in so closely to a line of argument I was already developing in a manuscript article ("Economic Calculation in the Corporate Commonwealth"), I thought I'd use this as the jumping-off point for publishing an excerpt here.

Disclaimer: I shouldn't have to say this, but for the record I do not favor government regulation of executive pay.

Mises denied any correlation between bureaucratization and large size in and of itself. Bureaucracy as such, he argued, was a particular rules-based approach to policy-making, as opposed to the profit-driven behavior of the entrepreneur. The point Mises neglected was the extent to which rational profit-driven entrepreneurial behavior becomes impossible because of the information and coordination problems inherent in large size. The large corporation, necessarily, distributes the knowledge relevant to informed entrepreneurial decisions among many departments and sub-departments, until the cost of aggregating them outweighs the benefits of doing so.

Try as he might, Mises could not exempt the capitalist corporation from the problem of bureaucracy. One cannot define bureaucracy out of existence, or overcome the problem of distributed knowledge, simply by using the word "entrepreneur." Mises tried to make the bureacucratic or non-bureaucratic character of an organization a simple matter of its organizational goals, rather than its functioning. In seeking to solve the problem by definition, by making profit-seeking the defining characteristic of the "entrepreneurial" organization as a whole, Mises resembled the collectivists who try to solve agency problems by positing a "new socialist man." The motivation of the corporate employee, from the CEO down to production worker, will be profit-seeking; his will is in harmony with that of the stockholder because he belongs to the stockholder's organization.

By defining organizational goals as "profit-seeking," Mises--like the neoclassicals--treated the internal workings of the organization as a black box. In treating the internal policies of the capitalist corporation as inherently profit-driven, Mises simultaneously treated the entrepreneur as some kind of indivisible actor whose will and perception permeate the entire organization. Although (as we see below) Mises at one point explicitly denied that the entrepreneur was omnipresent, in practice he viewed his entrepreneur as a brooding omnipresence whose influence guided the action of every employee from CEO to janitor.

Mises viewed the separation of ownership and control, and the agency problems resulting from it, as largely non-existent. The invention of double-entry bookkeeping, which made possible the separate calculation of profit and loss in each division of an enterprise, as "reliev[ed] the entrepreneur of involvement in too much detail." The only thing necessary to transform every single employee of a corporation, from CEO on down, into a perfect instrument of his will was the ability to monitor the balance sheet of any division or office and fire the functionary responsible for red ink.

It is the system of double-entry bookkeeping that makes the functioning of the managerial system possible. Thanks to it, the entrepreneur is in a position to separate the calculation of each part of his total enterprise in such a way that he can determine the role it plays within his whole enterprise. Thus he can look at each section as if it were a separate entity and can appraise it according to the share it contributes to the success of the total enterprise. Within this system of business calculation each section of a firm represents an integral entity, a hypothetical independent business, as it were. It is assumed that this section "owns" a definite part of the whole capital employed in the enterprise, that it buys from other sections and sells to them, that it has its own expenses and its own revenues, that its dealings result either in a profit or in a loss which is imputed to its own conduct of affairs as distinguished from the result of the other sections. Thus the entrepreneur can asign to each section's management a great deal of independence. The only directive he gives to a man whom he entrusts with the management of a circumscribed job is to make as much profit as possible. An examination of the accounts shows how successful or unsuccessful the managers were in executing this directive. Every manager and submanager is responsible for the working of his section or subsection. It is to his credit if the accounts show a profit, and it is to his disadvantage if they show a loss. His own interests impel him toward the utmost care and exertion in the conduct of his section's affairs. If he incurs losses, he will be replaced by a man whom the entrepreneur expects to be more successful, or the whole section will be discontinued. At any rate, the manager will lose his job. If he succeeds in making profits, his income will be increased, or at least he will not be in danger of losing it. [Human Action, p. 305]

Mises also identified outside capital markets as a control mechanism limiting managerial discretion. Of the popular conception of stockholders as passive rentiers, and of managerial control, he wrote:

This doctrine disregards entirely the role that the capital and money market, the stock and bond exchange, which a pertinent idiom simply calls the "market," plays in the direction of corporate business.... In fact, the changes in the prices of common and preferred stock and of corporate bonds are the means applied by the capitalists for the supreme control of the flow of capital. The price structure as determined by the speculations on the capital and money markets and on the big commodity exchanges not only decides how much capital is available for the conduct of each corporation's business; it creates a state of affairs to which the managers must adjust their operations in detail. [Human Action, pp. 306-07]

Mises' naivete is almost breathtaking. One can hardly imagine the most hubristic of state socialist central planners taking a more optimistic view of the utopian potential of numbers-crunching.

Peter Klein, in his excellent study of economic calculation arguments as they affect firm size, ["Economic Calculation and the Limits of Organization," The Review of Austrian Economics Vol. 9, No. 2 (1996): 3-28] argues that Mises foreshadowed Henry Manne's treatment of the mechanism by which entrepreneurs maintain control of corporate management. So long as there is a market for control of corporations, the discretion of management will be limited by the threat of hostile takeover. Although management possesses a fair degree of administrative autonomy, any significant deviation from profit-maximization will lower stock prices and bring the corporation into danger of outside takeover. ["Mergers and the Market for Corporate Control," Journal of Political Economy 73 (April 1965) 110-20; however, Klein cites the argument by Williamson, in Markets and Hierarchies, that the internal structure of the M-form corporation is more effective than external control devices like the capital market; see also Roberta Romano's "A Guide to Takeovers: Theory, Evidence, and Regulation," Yale Journal on Regulation 9 (1992): 119-80, for a survey of the debate on the effectiveness of the takeover threat.]

The question is whether those making investment decisions--whether senior management allocating capital among divisions of a corporation, or outside finance capitalists--even possess the information needed to assess the internal workings of firms and make appropriate decisions.

How far the real-world process of internal allocation of finance differs from Mises picture, is suggested by Robert Jackall's account of the actual workings of a corporation (especially the notorious practices of "starving" or "milking" an organization in order to inflate its apparent profit in the short-term). Whether an apparent profit is sustainable, or an illusory side-effect of eating the seed corn, is often a judgment best made by those directly involved in production. The purely money calculations of those at the top do not suffice for a valid assessment of such questions.

One big problem with Mises' model of entrepreneurial central planning by double-entry bookkeeping: it is often the constraints of the "general plan," as refined at each level of the hierarchy, that result in red ink at lower levels. Those at lower levels have their hands tied by the irrational constraints imposed from above. But those above them in the hierarchy refuse to acknowledge the double-bind they put their subordinates in. "Plausible deniability," the downward flow of responsibility and upward flow of credit, and the practice of shooting the messenger for bad news, are what lubricate the wheels of any large organization.

As for outside investors, participants in the capital markets are even further removed than corporate management from the data needed to evaluate the efficiency of factor use within the "black box." In practice, hostile takeovers tend to gravitate toward firms with low debt loads and apparently low short-term profit margins. The corporate raiders are more likely to "smell blood" when there is the possibility of loading up an acquisition with new debt and "milking" it (stripping it of assets) for short-term returns. The best way to avoid a hostile takeover, on the other hand, is to load an organization with debt, and inflate the short-term returns by milking its long-term productivity.

Another problem, from the perspective of those at the top, is determining the significance of red ink--or of black ink, for that matter. How does the large-scale investor distinguish red ink that results from senior management's gaming of the system in its own interest at the expense of the productivity of the organization, from red ink that results from the normal effects of the business cycle? And the "gaming" might be purely defensive, a way of deflecting pressure from those above whose only concern is to maximize apparent profits without regard to how short-term savings might result in long-term loss. The practices of "starving" and "milking" organizations that Jackall made so much of--deferring needed maintenance costs, letting plant and equipment run down, and the like, in order to inflate the quarterly balance sheet--resulted from just such pressure, as irrational as the pressures Soviet enterprise managers faced from Gosplan.

The problem is complicated when the same organizational culture--determined by the needs of the managerial system itself--is shared by all the corporations in an oligopoly industry, so that the same pattern of red ink appears industry-wide. It's complicated still further when the general atmosphere of state capitalism enables the corporations in a cartelized industry to operate in the black, despite excessive size and dysfunctional internal culture. It becomes impossible to make a valid assessment of why the corporation is profitable at all: does the black ink result from efficiency, or from some degree of protection against the competitive penalty for inefficiency? If the decisions of MBA types to engage in asset-stripping and milking, in the interest of short-term profitability, result in long-term harm to the health of the enterprise, they are more apt to be reinforced than censured by investors and higher-ups. After all, they acted according to the conventional wisdom in the Big MBA Handbook, so it couldn't have been that that caused them to go in the tank. Must've been sunspots or something.

In fact, the conventional wisdom in the financial community sometimes results in censuring transgressions against the norms of corporate culture, even when they are quite successful by conventional measures. Costco's stock actually fell in value, in response to adverse publicity in the business community about its above-average wages. Despite Costco's having outperformed Wal-Mart in profit, Deutsche Bank analyist Bill Dreher snidely remarked "At Costco, it's better to be an employee or a customer than a shareholder." Nevertheless, in the world of faith-based investment, Wal-Mart "remains the darling of the Street, which, like Wal-Mart and many other companies, believes that shareholders are best served if employers do all they can to hold down costs, including the cost of labor." [Stanley Holmes and Wendy Zellner, "The Costco Way: Higher wages mean higher profits. But try telling Wall Street" Business Week Online April 12, 2004]

On the other hand, senior management may be handsomely rewarded for running a corporation into the ground, so long as they are perceived to be doing everything right according to the norms of corporate culture. In a story which Digg aptly titled "Home Depot CEO Gets $210M Severance for Sucking at Job," [the original, more prosaicly titled article appeared in the New York Times January 3, 2007] departing Home Depot Robert Nardelli received an enormous severance package despite abysmal performance. It's a good thing he didn't raise employee wages too high, though, or he'd probably be eating in a soup kitchen by now.

As you might expect, the usual suspects stepped in to defend Mr. Nardelli's honor. An Allan Murray article at The Wall Street Journal noted that he had "more than doubled [Home Depot's] earnings." And a cover story in the January 15 issue of Business Week sympathetically quoted Nardelli's complaint that "share price is the one measure of company performance that he can’t control." T. Blumer of BizzyBlog made quick work of these arguments. He mentioned, among other inconvenient facts, the ways in which Nardelli doubled those earnings:

* His consolidation of purchasing and many other functions to Atlanta from several regions caused buyers to lose touch with their vendors.....

* Firing knowledgeable and experienced people in favor of uninformed newbies and part-timers greatly reduced payroll and benefits costs, but has eventually driven customers away, and given the company a richly-deserved reputation for mediocre service. [BizzyBlog, January 8, 2007]

As for stock price being the one factor Nardelli couldn't control, Blumer observed:

Substitute “control”... with “manipulate.” Nardelli and his minions played every accounting, acquisition, and quick-fix angle they could to keep the numbers looking good, while letting the business deteriorate. The market is not stupid; HD’s poor share-price performance shows that investors have known for quite a while that the HD-Nardelli “success” story has not been genuine. The manipulation can make the numbers look good, and it takes some time for the chickens to come home to roost. [BizzyBlog January 8, 2007]

In fact, Nardelli's mismanagement goes further. Since I originally posted this, T. Blumer provided this additional bit of information:

I have since learned that Nardelli, in the last months before he walked, took the entire purchasing function out of Atlanta and moved it to .... India -- Of all the things to pick for foreign outsourcing.

I am told that "out of touch" doesn't even begin to describe how bad it is now between HD stores and Purchasing, and between HD Purchasing and suppliers.

Not only is there a language dialect barrier, but the purchasing people in India don't know the "language" of American hardware -- or even what half the stuff the stores and suppliers are describing even is.

I am told that an incredible amount of time, money, and energy is being wasted -- all in the name of what was in all likelihood a bonus-driven goal for cutting headcount and making G&A expenses look low ("look" low because the expenses have been pushed down to the stores and suppliers).